If you’re considering a hospital/physician recruitment agreement with a loan or income guarantee, remember that the doctor will likely have to pay tax on that money if the hospital forgives the debt.
The Tax Court recently sided with the IRS that that money a physician received from a hospital as part of an income guarantee became taxable income when the hospital forgave and cancelled the loan.
Darrel Wyatt, an obstetrician/gynecologist, was recruited by Putnam, Florida’s Putman Community Medical Center, to establish a practice in this medically underserved region. As part of the deal, he agreed to stay for at least four years, maintain active medical staff membership at the hospital and other obligations. Wyatt and the hospital signed a Net Collectable Revenue Guarantee with Repayment Forgiveness, where the hospital would advance Wyatt a monthly income guarantee of $32,953 for twelve months. The contract allowed Wyatt to request a deferred payment plan or for the hospital to have him sign a promissory note or perfect a security interest for repayment of the monies. However, those contingencies never occurred because Wyatt complied with all of the obligations in the recruitment agreement, causing the hospital to forgive and cancel the loan.
Wyatt included the income guarantee amounts on his 2009 tax return but never paid estimated tax on the money nor when filing the return. The IRS notified him that he owed tax on that amount, plus interest for failure to timely pay the tax.
Wyatt challenged the tax assessment. He first offered a compromise payment based on “doubt of liability” but didn’t include the loan amount forgiven as part of that compromise. The IRs considered and ultimately rejected the offer because the doubt of liability had not been established.
In trial, Wyatt argued that he wasn’t liable to pay tax on the forgiven loan because it wasn’t income – it was really a “nonrecourse” loan and he was never personally liable for repayment when it was cancelled and forgiven. Wyatt said that he wasn’t personally liable for repayment because he had never signed a promissory note, entered into a deferred payment plan or perfected a security interest.
The tax court disagreed... Money in a loan is not part of gross income when it’s lent because there is an obligation to repay it. But if the taxpayer ends up not having to repay it, it may then be considered income.
The court said he was still personally liable for that debt even though he hadn’t signed a signed a promissory note, entered into a payment plan or perfected a security interest. The reason he didn’t sign one of these repayment agreements is because he didn’t need to – the loan had been forgiven when he met his obligations in the recruiting agreement. Moreover, pursuant to the agreement the hospital could have taken legal action to collect any loan amounts due from Wyatt had he not met his obligations.
Wyatt also asked that the “addition” to tax – i.e., interest – not be applied here because there was “reasonable cause” for him not to have paid the tax in 2009. He claimed that he would have incurred financial hardship if he had paid the additional tax on the forgiven loan back then. He also asked for an interest abatement.
The court didn’t buy any of it. Wyatt he didn’t demonstrate any reasonable cause to forgive the interest or not pay any estimated taxes, for that matter. And he didn’t qualify for an interest abatement because he didn’t ask for one in a timely manner.
Physician/hospital recruiting agreements are a great tool to incentive physicians to relocate to areas where they’re needed. But the tax rules still apply.
It’s also worth noting that Wyatt appears to have represented himself in his challenge of the tax assessment. In retrospect this may not have been the wisest move. Putting aside whether there were additional legal arguments in his favor he might have made had he known about them, at least a competent tax advisor/counsel would have filed the requisite request for the interest abatement before the deadline and/or perhaps could have negotiated a compromise settlement that the IRS would have accepted and avoid the additional time and expense of tax court.
Resource: Tax Court ruling